Chris Daniels: State-owned generators exploit 'valuation rort'

Is the era of the state-owned energy enterprise over? A ground-breaking study published late last year by three University of Auckland academics has supplied some analytical grunt to the increasingly widespread notion that the energy SOEs with their intellectual genesis in the late 1980s may have outlived their usefulness.

The idea of a state-owned enterprise, running as any other commercial business would, providing a dividend, acting without fear or favour of its Government masters, was an attractive half-way house on the way to privatisation.

In some cases, such as Air New Zealand and Tranz Rail, the eventual privatisation failed, leaving taxpayers to bail out what they once owned. But with Telecom and Contact, the companies thrived.

But Contact works in the strangest of sectors - one totally dominated by state-owned rivals.

This Government does not want to privatise them and the National opposition is not saying what it intends.

How long can we live in a half-way house? An SOE model that was designed to prepare state-owned companies for privatisation is looking increasingly unsuitable for the big energy generator-retailers.

Home owners and businesses are unlikely to take much comfort from the fact that rising power bills are adding directly to the profits of three big state-owned power companies which then pay it back to the taxpayer by way of dividends each year - only to help pay for the social welfare benefits of low-income families struggling to pay the aforementioned power bill.

Investment in the New Zealand Electricity Industry, written by Dr Alastair Marsden, Dr Russell Poskitt (finance and accounting department) and Dr John Small (school of business and economics), was commissioned by US energy investor Alliant Energy and TrustPower. Alliant is one of the last big North American energy companies with investments here, through its 23.8 per cent ownership of TrustPower.

TrustPower is the smallest of the Big Five power companies. The others are the state-owned Meridian, Genesis and Mighty River, as well as Contact, the second biggest company on the New Zealand Stock Exchange.

The sceptical among us will be wary of US investors commissioning a report on the suitability of continued Government ownership of important infrastructure - after all, aren't they just the sort of people who want to buy the family silver cheap?

Our sceptic in this case would be wrong, because the report's authors and Alliant's New Zealand managing director, Simon Young, say there's no need for the Government to sell out. They do argue, however, that something needs to change.

At the heart of the report, and the core of the authors' argument for change, is the way all the big power generators value and, more importantly, revalue, their assets.

For it appears the Government-owned power companies are putting a much lower book value on their assets than their competitors in the private sector. This undervaluation helps to keep all our power bills down, of course - no bad thing for most homes and businesses. But part of the payment is not laid out in the monthly bill: the call on taxpayer funds that comes when a new power station needs to be built.

The value of their assets and the return they need to earn on them is used by the SOEs to work out their cost of capital.

New investment in electricity generation comes only if the operating earnings on the new power station is confidently predicted to cover the capital cost over its life.

Analysing the five years between 1999 and 2004, the authors found that the operating earnings of the five power companies were only two-thirds of their cost of capital.

"We found quite strong evidence that the industry revaluation of generation assets that have been made are insufficient to bring book values into line with market values."

They estimate that the market value of Contact's generation assets was 16 per cent below the book value reported in Contact's financial statements as at September 30, 2003. TrustPower's were about 20 per cent below their book value at the end of March 2004.

"However, the book values of the generation assets at June 30, 2004, for each of the three SOEs were found to be undervalued by about 50 per cent, compared with our estimate of their market value."

The analysis suggests that the book values of the SOEs' generation assets are also lower than their market values and so much lower than those that you would expect to see in a successful business that is not operated by the Crown.

This all means one thing: that in the fight for new investment in generation, be it windfarms, natural gas-fired power stations or hydro stations, the SOEs will win.

The electricity sector that has evolved during the past decade is neither fish nor fowl - it is not fully open to private investment but neither is it completely run by politicians and bureaucrats.

All this points to a huge distortion in the electricity market that could mean taxpayers forking out for reasons that are not clearly defined and sources of possibly cheap funding (Contact and TrustPower's shareholders) going untapped.

"The results suggest that the Government may be willing to accept a lower-than-expected return from its investment than would be acceptable to a commercially focused shareholder," the report says.

"This seems at variance with a key objective of the SOE Act - that SOEs should be as profitable and efficient as comparable businesses not owned by the Crown."

It also means that new generation is less likely to be coming from private funding. SOEs may also be more willing than those in the private sector to invest in more marginal projects.

"We believe the public sector will need to provide a disproportionate share of the new investment capital required."

When the world's merchant bankers are approached for the hundreds of millions of dollars required to build new electricity generation, they will be more likely to hand over the cheque to an SOE since it requires a lower return on its capital.

So how is this not a call for further privatisation? It's about making the SOEs work as they should, not privatising them, the report's authors say.

"The issues raised here derive primarily from the way the SOE model is operating. However, our analysis does not support an argument for further privatisation of generation assets at this time.

"Within the electricity sector there are serious weaknesses that would not be solved by privatisation and which are more easily addressed while assets are publicly owned."

Small advocates some kind of independent revaluation, making the market more transparent.

"If the taxpayer is subsidising the SOEs through their valuation policies, then let's have it out in the open," says Small and his colleagues.

Many people, especially after the recent years of poor rainfall and subsequent calls for energy conservation, may have little problem with greater Government intervention or control of the energy sector. But is this happening already through this valuation rort?

Genesis, after many months of intense lobbying, was last year able to convince the Government and its Treasury accountants to help underwrite its $500 million investment in a new gas-fired power station at Huntly.

Its status as an SOE was played down by the Government when it defended the backing.

It said that the plan for a new station at Huntly was the only new generation likely to be built soon, so it got the help. A private company would have got the same kind of support had it been ready with the next big generation investment.

The prospect of the Government acting as underwriter to a private power station builder seems unlikely, but Energy Minister Pete Hodgson swears it would have been looked on just as favourably.

But would such a request ever come? This research suggests that the Government-backed SOEs, with their undervalued assets, are setting off in the race for investment capital with a very handy head-start.

www. alliantenergy. co. nz